Monday, September 22, 2014

Distorting Reality Part 1: Confirmation Bias

In his magnum opus, History of Economic Analysis, the great economist Joseph Schumpeter said that the first thing a man will do for his ideals is lie.

However, I think it would have been more accurate to have said that the first thing a fool will do for his ideals is lie.  A man of even average intelligence need not lie.  All he needs to do is to filter the facts to suit his own needs.

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And God knows that people of all ideological stripes do this.  The difference is that some do so deliberately while most do it for the innocent reason that some facts, when taken in isolation, confirm their biases.

One of my favorite examples of this is when people who support raising the minimum wage cite a statistical study that seemingly supports their views.  For instance, a few days ago, an American friend of mine, a dyed-in-the-wool progressive Democrat, whom I like to spar with every once in a while, sent me a link to one of his favorite websites – Think Progress – that purported to support his views about the benefits of raising the minimum wage.

My friend ended the email with a quip – “Coincidence?  I think not.”

Sometimes, a coincidence is really just a coincidence.
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(In case there is any doubt, I do not support the minimum wage for reasons that I have posted here.  And no, it's not because I think that hiking the minimum wage will cause the economy to collapse.  I have heard many people who are supposedly on my side of the argument make such claims and I think it's ridiculous.)

I wish I could say that it had been the first time I had seen that link my friend had sent me.  It had been making its rounds all over the media ad nauseum by the time he had sent it to me.

The article that my friend sent me cited a report that was published in the Center for Economic and Policy Research, which in turn cited a simple evaluation that was conducted by Goldman Sachs.  The analysis found that the thirteen U.S. states where the minimum wage went up on January 1st 2014 had shown faster employment growth than the other states where the minimum wage remained at its 2013 level.

However, this study had some serious problems.

For one thing, people who claim that the minimum wage hike caused the greater increase in employment are making a fallacious argument.  That is because the statement is a clear violation of ceteris paribus (i.e., all other things being equal or held constant), which is at the core of any good analysis.

In order for the claim to have any merit whatsoever, all the states that raised their minimum wage rates and those that did not must be identical in all other respects.  In other words, the increase in the minimum wage must have been the only economic condition that changed.  This is clearly not the case.  For example, some states have better quality education; some have more open and friendlier immigration policies; others have higher tax rates; some states have higher concentrations of hi-tech jobs while others have higher concentrations of low-tech jobs, etc. etc. etc.

Due to the violation of the principle of ceteris paribus, it is just as valid to claim that employment figures in those states improved despite the minimum wage hike!

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Another thing that people ought to have noticed about the report was that it was posted on June 30th 2014.  The study was based on data that was collected only for six months!  Six months is hardly long enough to make any kind of credible statement about the economy.  Years of data are required to truly calculate the effects of minimum wage legislation or subsidies or changes to immigration law or tax breaks (and such a study does happen to exist!).  That is because both producers and consumers adapt to changing market conditions by varying speeds and varying degrees.

And have you ever considered how many economic transactions take place in any country at any given moment?  Millions, if not billions, of economic transactions are made at any given moment in time.  Even the most well-trained econometrician who looks at merely one of those data points will be able to come up with only one conclusion – the market is chaos!

This study doesn't even take economic inertia into consideration.  What that means is that not everyone responds to changing economic factors instantaneously.  For example, if you are an owner of a small construction company and you are contractually obligated to build a house within a month, and the government increased the minimum wage by 50%, you're not going to slash your workforce by half the very next day.  You still need to finish building that house within the month.  After you've met your contractual obligations, you might want to rethink your hiring practices, but not before then.

This study alone is hardly proof that the minimum wage leads to job growth.  In fact, considering the unsound structure of the study, even if those states had shown negative job growth, the study would not be an indictment of the minimum wage either.  In order to prove or disprove the benefits of the minimum wage, much more data is required.  Regardless of how these states performed, this study is nothing more than a meaningless statistic.

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Now I am by no means saying that my friend, or all those other progressives who pointed at this study and went “Take that, Republicans/Conservatives/Libertarians/Capitalists!” are deliberately being dishonest.  I think the pundits and politicians who are using that statistic to gain political capital or popularity or ratings or profits are crooks; but the vast majority of laymen who have looked to that study with hope are mostly people with good intentions.

However, Milton Friedman's aphorism about judging policies and programs by their intentions rather than their results being a mistake holds true yet again.

The unfortunate fact of the matter is that many people do not think things through when they see “studies” that confirm their biases.  This is completely understandable.  Most people would rather be proven right than proven wrong.

Bias is a powerful thing, which no one can say one is truly free from.  It offers people a blanket vision that covers disparate things such as their views of human nature, politics, economics, society, religion, philosophy, etc.  So when a person comes across a narrative that fits his vision of reality – when he finds something that validates his opinions – he is content to stop and is unlikely to ask further questions.

And this is exactly how sacred cows are created.

(End of Part 1)

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